March 21, 2017

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March 21, 2017

A Chapter 7 debtor’s failure to comply with a bankruptcy court order to preserve a $2 million dollar-plus collection of fine wines has led to the imposition of sanctions of over $1 million, most of which could be charged against the debtor’s otherwise exempt property.

The wine in question, after three years of litigation, was determined to be part of the bankruptcy estate of Jeffrey Prosser. Prosser used to own companies that provided telephone, internet and cable television service to the U.S. Virgin Islands. Both he and his companies filed bankruptcy in 2006. A recent, 66-page opinion from the U.S. District Court in the Virgin Islands sets forth this saga of the wine collection in great detail; if you are taken to

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September 22, 2014

Attorneys with secured lenders for clients may one day find themselves in the following hypothetical scenario: An attorney represents a secured lender in the workout of a loan that is owed by a small distressed borrower. The borrower finds a buyer for its assets (either in a § 363 sale or out-of-court short sale), and the borrower and buyer agree upon the basic terms of the sale transaction. However, the borrower’s counsel does not have the experience, time or resources to draft the sale transaction documents, so the responsibility to “just get it done” falls on the secured lender’s attorney, whose client has the biggest economic stake because it will likely receive most of the sale proceeds.

After the deal closes, it turns out that the borrower is subject to tax claims that could have been avoided if the sale had been done another way, or the borrower is stuck

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Attorneys with secured lenders for clients may one day find themselves in the following hypothetical scenario: An attorney represents a secured lender in the workout of a loan that is owed by a small distressed borrower. The borrower finds a buyer for its assets (either in a § 363 sale or out-of-court short sale), and the borrower and buyer agree upon the basic terms of the sale transaction. However, the borrower’s counsel does not have the experience, time or resources to draft the sale transaction documents, so the responsibility to “just get it done” falls on the secured lender’s attorney, whose client has the biggest economic stake because it will likely receive most of the sale proceeds.

After the deal closes, it turns out that the borrower is subject to tax claims that could have been avoided if the sale had been done another way, or the borrower is stuck with some pre-closing liabilities that it (mistakenly) thought the buyer was taking, or some other liability that counsel for the borrower should have addressed prior to or at the closing, but that the attorney did not care about or missed. The borrower sues — and the target of the suit is the attorney for the secured lender.
Many of us have been in this situation. The client, the secured lender, is very interested in finding a way to get the deal done. But the borrower’s counsel is slow, perhaps is not being paid, and likely does not have the resources of a larger firm to quickly move the matter along. This article will explore the liability issues raised in the aforementioned hypothetical scenario and provide practical advice for attorneys who find themselves in this or a similar situation.

Over the years, courts have held that a nonclient party may have standing to sue an attorney for malpractice, even though there is no privity of contract. Even absent fraud or collusion, courts have found that a mistake by an attorney, to the detriment of the nonclient party, could result in a viable claim — or at least a claim that will survive a motion to dismiss and likely a motion for summary judgment. Depending on the context, those courts have found that a nonclient party has the standing through the following theories of law: multi-criteria balancing test,1 third-party beneficiary theory,2 secondary implied privity theory, and voluntary or gratuitous agency theory.

All of these claims sound in tort, and as with all torts, in order to establish a claim, the plaintiff must show that the defendant owed a duty of care to the plaintiff.3 Of these theories, the “secondary implied privity” theory and the “voluntary or gratuitous agency” theory are most likely to be used by a borrower to establish a duty of care in the hypothetical scenario. The borrower is likely to raise the “secondary implied privity” theory because the attorney drafted the sale transaction documents for the borrower’s signature, which is something an attorney typically does for his/her own clients. Thus, or so the argument goes, it would be reasonable for the borrower to believe that the attorney represented the borrower’s interests too, creating an implied attorney/client relationship. In addition, the borrower is likely to raise the “voluntary or gratuitous agency” theory because the attorney offered to draft documents for the borrower, and in doing so, the attorney owed a duty of care to protect the borrower’s interest.

We are practitioners who occasionally deal with small, distressed borrowers, and we sometimes have to pick up the drafting pen more than is typical to move a transaction along with dispatch. As such, we think these theories are rubbish. Nonetheless, they exist.

Secondary Implied Privity Theory

Although lawyers are generally comforted by the principle that an attorney/client relationship arises only when there is privity of a contract between a lawyer and client, courts routinely find, as with other contracts, that the contractual relationship between a lawyer and client can be either expressed or implied.4 Such a relationship generally cannot be established absent evidence that the lawyer knew that the nonclient party assumed that the lawyer was representing him/her in a matter.5 In short, an attorney/client relationship may be implied from the conduct of the parties.6 In this situation, the question for the fact-finder is whether the attorney was aware, or should have been aware, that his/her conduct would have led a reasonable person to believe that the attorney was representing that person.7

In Kotzur, a purchaser in a real estate transaction claimed that the lawyer for the seller misled him into thinking that the title was being conveyed clear of all liens.8 The purchaser brought a legal malpractice claim against the lawyer, and the trial court granted summary judgment in favor of the lawyer, holding that the absence of an attorney/client relationship precluded a cause of action. The appellate court reversed, concluding that when (1) the lawyer admitted that he prepared all documents relating to the sale and that the transaction was done on a “family-type basis,” (2) a nonclient party testified that it was his impression that the lawyer was handling the documents for the transaction, and (3) the lawyer never told the nonclient party that he was not representing the nonclient party or to hire a separate lawyer, an issue of fact existed as to the nature of the relationship.

Similarly, in Burnap, lawyers were hired to represent a partnership in connection with the withdrawal of several partners.9 The matter included a mutual release and indemnity in favor of the withdrawing partners by Willard Burnap (who was one of the remaining partners). The lawyers had no direct contact with Burnap, but they did prepare numerous documents for Burnap’s signature. After the withdrawal was completed, Burnap’s indemnity was triggered, and he sued the lawyers for, among other things, professional malpractice. The trial court granted summary judgment for the lawyers, but, as in Kotzur, the appellate court reversed. The appellate court found that a question of fact existed as to whether an implied attorney/client relationship existed because the lawyers prepared numerous documents for Burnap’s signature, Burnap received no notice that the lawyers did not represent Burnap’s personal interests, and Burnap was never informed that his interests might be adverse to the interests of others involved.

In the hypothetical scenario, there is likely a question of fact as to whether the borrower reasonably believed that the attorney represented his interests, since the attorney drafted documents for the borrower’s signature for a sale transaction in which the attorney’s client was only indirectly involved (i.e., involved only to provide a lien release and to receive a check). The attorney also failed to notify the borrower that the attorney did not represent the borrower’s interests, even though he was acting on the borrower’s behalf.

Voluntary or Gratuitous Agency Theory

The doctrine of voluntary agency holds that when a professional (e.g., an attorney) gratuitously offers to perform a task, he/she owes a duty of care in completing that task.10 In brief, even when there is insufficient consideration for a promise to permit an action in contract, a promissor has a duty to fulfill the promise if he/she knows that his/her gratuitous promise has induced reasonable reliance.11 Reasonable reliance is required for this exception to the common law requirements of privity.

For example, in Wright v. Swint,12 the plaintiff purchased a parcel of real estate based on a defective title search performed by the lawyer for the lender. The plaintiff discovered this defect when he attempted to refinance, and when the plaintiff told this to the lawyer who originally closed the transaction, the lawyer gave “assurances” to the plaintiff that the defect was being cured. The trial court granted summary judgment for the attorney, concluding that the lawyer was never the plaintiff’s lawyer. The court of appeals reversed, however, holding that a jury could find that the lawyer owed the plaintiff a duty based on the lawyer’s assurances and purported attempt to fix the defective title.

Similarly, in Simmerson, the court determined that a lawyer who undertakes a task, even without payment, might be responsible for misfeasance, even though the lawyer would not have been liable had the lawyer never undertaken the task.13 Specifically, in Simmerson, after the closing, the lawyer for the seller told the purchaser that he would file all necessary papers evidencing the deal. The lawyer did so — but in the wrong county. Upon discovering the error, the purchaser sued the lawyer. The court of appeals reversed the trial court’s grant of summary judgment for the lawyer, finding that the lawyer was a voluntary agent and, as such, must “use a reasonable degree of care and skill, and … possess to a reasonable extent the knowledge requisite to a proper performance of the duties of his profession.”14

The particular relevance of Simmerson to even larger deals is when counsel for the secured lender undertakes to file UCC-3 termination statements upon confirmation of the receipt of funds from the buyer or new lender paying off the secured lender’s liens. In that instance, Simmerson is on all fours, and if the buyer or new lender is harmed by an untimely or incorrect UCC-3 filing by a secured lender’s lawyer, or the lawyer forgets to file it altogether, then watch out.

Applied to the hypothetical scenario, the borrower’s relationship with the attorney is foreseeable, as the attorney offered to draft, and indeed drafted, the sale transaction documents for the borrower’s benefit. Like the attorney in Wright who voluntarily offered to cure his prior defective title search, the attorney assured the borrower, albeit implicitly, that he would draft all of the necessary documents and would do so in a competent manner. Even though the attorney had no explicit duty to the borrower, having undertaken the task, the attorney was bound to draft the documents with the ordinary and reasonable skill of his profession. If the attorney misses something, then a claim for negligence is likely to follow, and the matter will likely go to trial in light of the cases above in which summary judgment for the defendant/attorney was denied.

How to Avoid Such Nonclient Liability

Because we now know that a court may find an attorney liable to a borrower for negligence under at least two theories, the next question is this: What steps should the attorney have taken to avoid such liability? The ABA Model Rules of Professional Conduct do not specifically address the hypothetical scenario presented in this article. A careful review of the ABA Rules, however, provides guidance to the hypothetical attorney. Comment [4] to ABA Rule 1.3 states that “[d] oubt about whether a client/lawyer relationship still exists should be clarified by the lawyer, preferably in writing, so that the client will not mistakenly suppose [that] the lawyer is looking after the client’s affairs when the lawyer has ceased to do so.” Rule 1.13 (f) (“Organization as Client”) affirmatively requires a lawyer to “explain the identity of the client” when the interests of a client organization are adverse to those of its constituents. Comment 10 to Rule 1.13 (f) (“Clarifying the Lawyer’s Role”) further directs the organization’s lawyer in such a situation to ensure that the constituent understands that “the lawyer for the organization cannot provide legal representation for that constituent individual.”

When in doubt, refer to the ABA Rules. Even though the ABA Rules do not address the exact hypothetical mentioned at the beginning of this article, they do provide guidance for similar situations, and the guidance consistently requires the attorney to clarify who he/she represents, preferably in writing.

This advice is consistent with the warnings from case law. For instance, in Fox, a legal malpractice case brought by an unrepresented party in a real estate transaction, the court noted that “neither appellants nor respondent specifically recall [the] respondent advising them to seek independent counsel, and there is no written notice or advice to such effect.”15 Thereafter, the Court made the following statement:

Attorneys in these circumstances are well advised to place a disclaimer in writing. A simple clause in the agreement stating that it was prepared by the attorney for the opposite party acting solely on behalf of that party’s interest, and advising the other parties to seek independent legal counsel to protect their own interest, might have prevented this action from being filed.

As another example, a North Carolina State Bar Ethics Opinion provides that in real estate transactions, an attorney may, with proper notice to the borrower, represent only the lender, and the lender may prepare the closing documents.16 The Ethics Opinion further explains that as long as the attorney clearly explains to the borrower that he/she represents only the lender and makes that disclosure far enough in advance of the closing so that the borrower can procure his/her own counsel, the attorney has no duty to notify the borrower of potential defects in the title. The Ethics Opinion also strongly suggests that the notice be in writing.

Practical and Easy Steps

If there is any potential ambiguity about whether the lawyer represents specific nonclient parties, the lawyer should send a “non-representation” letter to each of them. Consider using the following language:

This firm is representing [name your client] in [describe nature of the matter]. While you have not requested that we represent you, we want to make it clear that we do not represent you in this matter, and you should not look to us for protection of your interests in the matter. Given [describe client’s role in matter], however, the firm drafted [describe documents]. The [describe documents] were prepared solely in the interest of [name your client]. Our initial draft nor any future input shall create any implication that the firm represents anyone other than [name your client]. We recommend that you obtain other counsel

Such a letter should be sent certified mail with proof of mailing retained; it is the simplest way to avoid potential liability to nonclient parties while still pushing the deal forward for your secured lender client.

See, e.g., Lucas v. Hamm, 364 P.2d 685, 688 (Cal. 1961) (factors include extent to which transaction was intended to affect plaintiff, foreseeability of harm to plaintiff, degree of certainty that plaintiff suffered injury, closeness of connection between defendant’s conduct and injury, policy of preventing future harm and extent to which profession would be unduly burdened by finding of liability).

See, e.g., Flaherty v. Weinberg, 492 A.2d 618, 622 (Md. 1985) (nonclient party must allege and prove that intent of client to benefit nonclient party was direct purpose of transaction or relationship).

See, e.g., Palsgraf v. Long Island R. Co., 162 N.E. 99 (N.Y. 1928) (absent duty owed by defendant to plaintiff, there can be no tort claim) (Cardozo, C.J.); Tarasoff v. Regents of Univ. of Cal., 551 P.2d 334, 343 (Cal. 1976) (“[A] duty of care may arise from ‘… a special relation … between the actor and the other, which gives to the other a right of protection.’”).

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